LONDON Morgan Stanley has become the latest Wall Street bank to turn bullish on local emerging market bonds, though its strategists said they remained wary of developing economies' currencies in the face of a dollar that is set to remain strong.
"We upgrade our stance on EM local currency bonds to bullish, where we have held a neutral stance for much of the year," Morgan Stanley strategist James Lord said in a note to clients dated Friday.
"EM rate cuts are on their way, ahead of the Fed," said Lord in the bank's emerging markets mid-year outlook note titled "it's all downhill from here" and distributed on Monday.
The combination of price, yield and FX leaves total returns for local currency bonds in emerging markets at around 2% by year-end, Lord calculated, adding hard-currency bond returns could come in at 4.5%, Lord said. However, currencies could rack up a loss of around 2% at index level on a total return basis.
"Already, carry and bond price gains have delivered for investors this year even if FX has not."
Other Wall Street banks have also turned upbeat. In a note published on Friday, JPMorgan moved its recommendation emerging market local bonds back to "overweight" from "market weight".
"We prefer EM local to hard currency bonds for 2H23," Luis Oganes, head of global macro research at JPMorgan wrote in a note to clients.
"We are OW (overweight) across all regions and long duration should continue to perform as the beginning of EM cutting cycles approaches," Oganes said, adding the bank remained market weight on emerging market FX overall.
Emerging market central banks had been quick to raise rates in 2021, frontrunning major peers such as the U.S. Federal Reserve and the European Central Bank.
First signs of a turning of the cycle in emerging markets emerged in recent weeks with Hungary becoming the first European central bank to ease policy after Uruguay became the first to cut in Latin America.
(Reporting by Karin Strohecker; Editing by Conor Humphries)
